Arizona’s Anti-Deficiency Law Continues to Evolve

With the increased number of foreclosures experienced in Arizona over the last several years, the Arizona Court of Appeals continues to issue significant decisions addressing previously unresolved questions pertaining to the protections afforded by Arizona’s anti-deficiency statutes.  This trend continued on March 20, 2012 with the court’s published opinion in Helvetica Servicing, Inc. v. Pasquan, 1 CA-CV 10-0418.

In Pasquan, the Court of Appeals addressed three significant legal questions pertaining to Helvetica’s judicial foreclosure of the Pasquans’ Paradise Valley home, which was secured by a loan with Helvetica in the principal amount of $3,657,793.30.  Specifically at issue was Helvetica’s right to a deficiency judgment against the Pasquans in the approximate amount of $3,200,000.00 following Helvetica’s purchase of the property at a sheriff’s sale pursuant to a $400,000.00 credit bid.

In an effort to determine the Pasquans’ alleged deficiency liability, the Court of Appeals first addressed the issue of whether a purchase money loan loses its purchase money distinction and thus its deficiency protection following a refinance.  Upholding its previous decision in Bank One v. Beauvais, 188 Ariz. 245, 934 P.2d 809 (App. 1997), the court held that a refinance in and of itself does not destroy the loan’s purchase money status, stating that “A change in the lender’s identity does not, standing alone, alter the nature of the underlying purchase money debt.”  Accordingly, refinancing a purchase money loan with a new lender does not cause the borrower to forfeit their anti-deficiency protection.

The second issue addressed by the Court of Appeals is whether a construction loan qualifies as purchase money in nature, and is thereby eligible for anti-deficiency protection.  This issue is not directly addressed by Arizona’s anti-deficiency statues because the borrowed funds on a construction loan are not used simply to purchase a qualifying residential property.  Rather, construction loans are typically used in part to purchase raw land and in part to pay for the services performed by contractors.  Although property improvement loans do not constitute purchase money obligations, the Court of Appeals in Pasquanruled that “a construction loan qualifies as a purchase money obligation if: (1) the deed of trust securing the loan covers the land and the dwelling constructed thereon; and (2) the loan proceeds were in fact used to construct a residence that meets the size and use requirements set forth in A.R.S. § 33-729(A)” i.e. – a single one-family or single two-family dwelling on less than two and one-half acres.

Finally, the Court in Pasquan addressed “cash-out” refinances and examined whether a lender is entitled to a deficiency judgment following the foreclosure of a loan where only a portion of the borrowed funds constitute purchase money.  While lenders have long argued that the entire deficiency is a recourse obligation on blended loans of this nature, borrowers have asserted that the entire loan receives the protection afforded by Arizona’s anti-deficiency statutes.  In what appears to be a well-reasoned compromise, the Court of Appeals very simply held that the purchase money portion of the loan is eligible for anti-deficiency protection while the cash-out portion is not.

In explaining its rationale, the Court expressed that on the one hand, “it appears unnecessarily punitive and contrary to the consumer-protection goals of Arizona’s legislature to convert an entire obligation into a recourse loan simply because it happens to include non-purchase money sums.”  Alternatively, “it seems similarly inappropriate to shield borrowers from deficiencies for loan disbursements unrelated to the acquisition or construction of a qualifying residence.”   Following a foreclosure, the lender may therefore seek to recover a deficiency judgment only on the non-purchase money portion of the loan.  However, in order to obtain such a judgment, the lender must first trace and segregate the non-purchase money funds.

While the decision in Pasquan may be appealed to Arizona’s Supreme Court, for now the case provides further clarification of Arizona’s evolving anti-deficiency statutes and their application to construction loans and “cash-out” refinances.